How Can Life Insurance Help My Estate Plan?

In the 1990s, it wasn’t unusual for people to buy second-to-die life insurance policies to help pay federal estate taxes. However, in 2019, with estate tax exclusions up to $11,400,000 (and rising with the cost-of-living adjustments), fewer people would owe much for estate taxes.

However, IRAs, 401(k)s, and other accounts are still 100% taxable to the individuals, spouses and their children. The stretch IRA options still exist, but they may go away, as Congress may limit stretch IRAs to a maximum of 10 years.

Forbes’ recent article, “3 Ways Life Insurance Can Help Your Estate Plan,” explains that as the IRA is giving income from the RMDs, it may also be added, after tax, to the life insurance policy. If this occurs, it’s even possible that the death benefits could grow in the future, giving a cost-of-living benefit to children. This is one way how life insurance can be used creatively to help your estate plan.

For married couples, one strategy is to consider how life insurance on one individual could be used to pay “conversion tax” at death, using tax-free benefits. When the retiree dies, the spouse beneficiary can then convert all the IRA (taxable money) to a Roth IRA, which is tax-exempt with new, lower income tax rates (37% in 2018-2025 versus 39.6% in 2017 or earlier).

This tax-free death benefit money can be used to pay the taxes on the conversion, letting the surviving beneficiary have a lifetime of tax-exempt income without RMD issues from the Roth IRA. The Social Security income could also be tax-exempt, because Roth withdrawals don’t count as “income” in the calculation to see how much of your Social Security is taxed. However, you’d have to be within the threshold for any other combined income.

Life insurance for both individuals (if married) may also be a good idea. If the spouse of the IRA owner dies, the money from the life insurance can be used once again. If this is done in the tax year of the death for married individuals, the tax conversion could be done under “married filing status” before the next year, when the individual must use single tax filing status.

Another benefit of the IRA-to-Roth conversion is the passing of Roth IRAs to heirs, which could create a lasting legacy, if planned well. New life insurance policies that add long-term care features with chronic care and critical care benefits can also provide an extra degree of benefits, if one of the insureds has health issues prior to death.

Be sure to watch the tax rates and possible changes. With today’s lower tax rates, this could be very beneficial. Remember that there are usually individual state taxes as well. However, considering all the tax-optimized benefits to spouses and beneficiaries, the long-term tax benefits outweigh the lifetime tax liabilities, especially when you also consider SSI tax benefits for the surviving spouse and no RMD issues.

Life insurance in retirement can help protect, build and transfer wealth in one of the easiest ways possible. If you’re not certain about where to start with your life insurance needs, speak with an experienced estate planning attorney.

Reference: Forbes (November 15, 2019) “3 Ways Life Insurance Can Help Your Estate Plan”

What Should I Know about Estate and Inheritance Taxes with Property in Two States?

If you’re set to receive your full Social Security benefits next year, you may want to make sure you understand the estate and inheritances taxes of owning property, especially if it’s in more than one state.

Let’s say you own two co-ops in Manhattan and a home in New Jersey. All are all mortgage-free but you have a $69,000 home equity loan on the house. You may wonder if it’s better to continue to live in New Jersey with assets in New York or to move back to New York—or even somewhere else. This decision should be based at least in part on how your assets will be taxed, when you pass away. You also want to think about the beneficiaries of your property.

nj.com’s recent article asks, “Are estate and inheritances taxes worse in New York or New Jersey?” The article explains that estate and inheritance taxes are two different things, and it’s important to understand them.

An estate tax is levied on the estate of the decedent. An inheritance tax is paid by the beneficiary who gets the distribution from the estate. Few states have inheritances taxes. New Jersey abandoned their estate tax effective Jan. 1, 2018. However, New Jersey still has an inheritance tax. It is only applicable to non-Class A beneficiaries, which typically are heirs who are not lineal descendants. Children or grandchildren are Class A beneficiaries, so the inheritance tax would not apply to them.

There’s no inheritance tax in New York. However, the estate tax is imposed on taxable estates in excess of the state exemption. That’s $5.49 million in 2019 and will go up to $5.85 million in 2020. New York estate tax rates begin at 3.06% and increase to 16.0% for taxable estates in excess of $10.1 million.

An estate of a New York non-resident is required to file a New York State estate tax return, if the estate includes any real or tangible property in New York State and the amount of the non-resident’s federal gross estate, plus the amount of any “includable gifts,” is more than the state’s exclusion amount at the time of death. “Includable gifts” are gifts made while the decedent was a New York resident during the preceding three-year period ending on the date of death. These aren’t included in the decedent’s federal gross estate.

In the example above, it looks like New Jersey would be the better domicile in which to claim residency, because no estate or inheritance tax would be due. Depending on the value of the two co-ops in New York, he may owe New York estate tax, if the value exceeds the New York State estate exclusion amount. That’s true whether he’s a New York or New Jersey resident.

Under current New Jersey law, moving to another non-estate tax state, like Florida, won’t help him with any additional estate tax benefit. As always, talk with an estate planning attorney regarding the above specifics and to make certain that your estate plan is complete and follows your goals.

Reference: nj.com (December 4, 2019) “Are estate and inheritances taxes worse in New York or New Jersey?”

What Does Portability Mean, and How Do I Use It?

WMUR’s recent article, “Money Matters: Portability and estates,” explains that each taxpayer is typically permitted what is called an applicable exclusion amount. This is the amount of assets that, at your death, you can bequeath to others tax-free for estate tax purposes. Prior to the law change, spouses couldn’t share their exclusions. However, the Tax Cuts and Jobs Act increased this exclusion significantly. In 2019, the exclusion is $11.4 million per person.

The portion that’s not used by the deceased spouse can be transferred to the surviving spouse. The exclusion is indexed for inflation. However, this exemption level is only in effect until 2025. It will then again lower, probably to around half of its current level.

Before this tax law change, the most frequent way to maximize the exclusion was to set up a trust for each spouse—sometimes known an A/B trust. When the first spouse passes away, an amount equal to the exclusion would go to the B trust (also called a credit-shelter bypass trust).

The assets in this trust would be outside the surviving spouse’s estate and, because the exclusion was applied, were not subject to estate taxes. Anything remaining in the estate of the first to die, would be given to the survivor or could be placed in another trust. This trust is often called an A trust (or marital trust). Transfers to spouses aren’t usually subject to estate tax, so assets passing to the A marital trust would have no estate tax liability. At the surviving spouse’s death, his exclusion would be applied to the assets in the A trust. That way, both spouses would get the benefit of their exclusion.  However, this changed with the new tax law. The first spouse to die now uses the exclusion against assets in his estate. Any unused exclusion amounts can then be used by the surviving spouse with their own, at her death.

This would appear to simplify estate planning, for some, the use of two separate trusts will no longer be needed. However, remember these thoughts: (i) the unused applicable exclusion amount from an earlier marriage usually isn’t available, and you can use the amounts only from your last deceased spouse in your estate planning; (ii) these unused exclusion amounts aren’t indexed for inflation, so the property your spouse receives at your death may increase in value in the future, and its value could ultimately be greater than the unused exclusion; and (iii) to use portability, an estate tax return must be filed, so the estate executor must make an election to do so, by filing a return—even if the estate wouldn’t usually be required to do so.

Because of the tax law changes, estate documents drafted before 2010 may not accurately reflect your desire,s because portability and the increase in the exclusion amount can have an effect. Review the changes with your estate planning attorney.

Reference: WMUR (November 21, 2019) “Money Matters: Portability and estates”

Can You Explain the Concept of Step-Up Basis?

If you inherit assets—especially real property—you need to understand the step-up in basis rules. These rules can save you a lot of amount of money on capital gains and depreciation recapture taxes.

Motley Fool’s recent article on this subject asks “What is a Step-Up in Basis?” The article explains that step-up in basis has significant implications for inherited property. When an asset is inherited because the original owner has passed away, in many cases, it’s worth more than when it was first purchased. To avoid a huge capital gains tax bill when the inherited property is sold, the cost basis of the asset is modified to its value at the time of its owner’s death. This is called a step-up in basis. Note that this only applies to property transferred after death. If a property was gifted or transferred before the original owner dies, the original cost basis would transfer to the recipient.

This is a gigantic tax benefit for estate planning, regardless of whether you go ahead and sell the inherited asset immediately or hold on to it for a time. While a step-up in basis can let heirs avoid capital gains taxes, it doesn’t allow heirs to avoid estate taxes that apply to big inheritances.

The estate tax this year is imposed on property in excess of $11.4 million per individual and $22.8 million per married couple. Therefore, if you and your spouse leave a $25 million estate to your heirs, $2.2 million of this will still be taxable, even though your heirs’ cost basis in assets they inherited will be stepped up for capital gains tax purposes.

There are many strategies that a qualified estate planning attorney can advise you on to avoid estate taxes, but step-up in basis doesn’t exclude the value of inherited property from a taxable estate all by itself.

There are two significant ramifications of stepped-up cost basis regarding inherited real estate assets. First, like with other assets, you don’t have to pay capital gains on any appreciation that occurred before you inherited the property. Selling an investment property after years of holding it, can mean a massive capital gains tax bill. Therefore, a stepped-up cost basis can be a very valuable benefit. A step-up in basis can also give you a larger depreciation tax benefit. The cost basis of residential real estate can be depreciated (deducted) over 27½ years: a higher number divided by 27½ years is a greater annual depreciation deduction than a smaller number would produce.

Estate transfers are pretty complicated, so work with a qualified estate planning attorney.

Reference: Motley Fool (November 21, 2019) “What is a Step-Up in Basis?”

What Can I Do with an Inherited 401(k)?

Inheriting a 401(k) at the death of the account owner isn’t always as simple as inheriting a home or a piece of jewelry. The IRS has rules that 401(k) beneficiaries must follow that say when and how much tax they’ll pay to inherit someone else’s retirement plan. If you’re currently the beneficiary of a 401(k) or you’ve recently inherited one, here are some important things you need to know.

Smart Assets’s recent article entitled “A Guide to Inheriting a 401(k)” explains that if a spouse of the account owner waives their right to inherit a 401(k) or the account owner is unmarried, they can leave their account to whomever they want at their death.

An inherited 401(k) is taxed is based on three key factors: (i) your relationship to the account owner; (ii) your age when you inherit the 401(k); and (iii) the account owner’s age when they die.

There’s also several ways to take a distribution from a 401(k) when you’ve inherited it: you can do a lump sum, periodic payments, or distributions stretched out over your life expectancy.

If you inherit a 401(k) from your spouse, what you decide to do with it and the subsequent tax impacts may be based primarily upon your age. If you’re under age 59½, you have a choice of three things:

  1. Keep the money in the plan and take distributions. You can take withdrawals from the account without the 10% early withdrawal penalty. You’d still pay regular income tax on any distributions you take. If your spouse was age 70½ or older when they passed away, you would have to take required minimum distributions from this account. There’d be no early withdrawal penalty. However, you’d pay income tax on the withdrawals. If the spouse was younger than 70½ when they died, you could wait to take RMDs until you turn 70½.
  2. Move the money to an inherited IRA. This is an IRA that’s designed to hold rollover funds from an inherited retirement plan, including 401(k)s. You can make withdrawals without any early withdrawal penalty. With this type of account, you’d need to take RMDs. However, the amount would be based on your own life expectancy, not the amount your spouse would have been required to take.
  3. Move the money to your own IRA. If you already have an IRA, you could roll an inherited 401(k) into it with no tax penalty. However, if you’re under age 59½ when you execute the rollover, the withdrawal will be treated like a regular distribution, so you’ll pay income tax on the full amount, along with the 10% early withdrawal penalty. If you’re over age 59½, you won’t pay an early withdrawal penalty with any of these options. If your spouse was taking RMDs from their 401(k) when they died, you’d have the option to continue taking them or delay taking them until you turn 70½. If you’re already 70½ or older, you’d need to take RMDs, regardless of whether you leave the money in the 401(k), transfer it to an inherited IRA or roll it over to your existing IRA.

If you inherit a 401(k) from someone other than your spouse, your options are linked to how old the account owner was when you inherited the plan and the plan’s distribution rules. If the account owner hadn’t yet turned 70½, the plan may let you spread distributions out over your lifetime or spread them out over a five-year period. If you take the five-year option, you may have to fully withdraw all of the account assets by the end of the fifth year following the account owner’s death. In either case, you’d pay income tax on the withdrawals.

You could also roll the account over to an inherited IRA, if the plan permits this. Here, the RMDs would be based on your life expectancy, assuming the account owner hadn’t started taking them yet. If they had started with their RMDs, you’re required to continue taking those distributions. However, you could base the distribution amount on your life expectancy, rather than that of the account owner.

Speak with an experienced estate planning attorney to help you determine the route that makes the most sense to reduce taxes, while planning ahead for the future.

Reference: Smart Asset (October 22, 2019) “A Guide to Inheriting a 401(k)”

Will My Heirs Need to Be Ready to Pay Estate Taxes?

Estate taxes all depend on how on much a person is planning to give to heirs.

Motley Fool’s recent article asks “If I Leave My Retirement Savings to My Heirs, Will They Pay Estate Tax?” The article tells us that retirement accounts like 401(k)s, 403(b)s, traditional and Roth IRAs and others are a part of your taxable estate.

However, unless the total assets of your estate plus any taxable gifts you’ve already given are more than the lifetime exclusion amount, your estate won’t owe estate taxes.

For 2019, this is $11,400,000, and in 2020, the exclusion will be raised to $11,580,000. If you total all of your assets’ value, only the amount in excess of the exclusion will be taxable. Therefore, if you have a $12,000,000 estate and die in 2020, only $420,000 of your assets would be subject to estate taxes.

Let’s look at another example: if your assets, including your retirement savings, total up to $5 million, your heirs won’t be required to pay any estate tax whatsoever.

However, while they may not have to pay estate taxes, remember that withdrawals from most retirement accounts (except Roth IRA accounts) will be deemed to be taxable income. Thus, estate tax or no estate tax, if your heirs are in a pretty high tax bracket, inheriting your retirement savings may increase their tax liability.

Don’t neglect to check with an estate planning attorney about your state’s estate and inheritance taxes. There are a handful of states that have their own estate taxes, and their thresholds may be lower than the IRS’s.

There are now six states with an inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania.

Each state sets its own inheritance tax exemption, and inheritance tax rates. However, these rates are subject to change at any time with changes to the laws in those states.

Reference: Motley Fool (November 8, 2019) “If I Leave My Retirement Savings to My Heirs, Will They Pay Estate Tax?”

What Should I Do If I Strike it Rich?

There’s nothing quite like getting an unexpected sum of money. That happiness can be magnified when the amounts are six, seven, eight digits or more.

However, the greater the amount you receive, the greater your stress.

Investopedia’s recent article, “Tips For Handling Sudden Wealth” reports that there’s even a stress-related disorder called “Sudden Wealth Syndrome.”

This stress results in the recipients doing things that will threaten their good fortune and may leave them worse off than before they got the money.

Let’s look at few ideas to help you hang onto that new wealth:

  1. Tally your money. Take the time to carefully review all the documentation associated with the windfall. Note the areas you don’t understand and talk with your attorney.
  2. Create a comprehensive financial and life plan. Don’t settle for a cookie-cutter solution. Look for customization that takes into account your circumstances, your goals and your desired legacy.
  3. Be wary of friends and family. A downside of sudden new wealth is that new friends and estranged family members may come out of the woodwork. One idea is to pay yourself a salary, which can put some distance between you and these people.
  4. Don’t buy big ticket items, until you’re comfortable with the advice and understand your new financial position. You should address your taxes on the gain, pay down debts or take a small vacation. However, don’t make too many changes all at once. Talk to your advisors.

More money can mean more problems. Use these tips and consult with your attorney, when deciding what to do with your newfound riches.

Reference: Investopedia (June 25, 2019) “Tips For Handling Sudden Wealth”

As a Trust Beneficiary, Am I Required to Pay Taxes?

When an irrevocable trust makes a distribution, it deducts the income distributed on its own tax return and issues the beneficiary a tax form called a K-1. This form shows the amount of the beneficiary’s distribution that’s interest income, as opposed to principal. With that information, the beneficiary know how much she’s required to claim as taxable income when filing taxes.

Investopedia’s recent article on this subject asks “Do Trust Beneficiaries Pay Taxes?” The article explains that when trust beneficiaries receive distributions from the trust’s principal balance, they don’t have to pay taxes on the distribution. The IRS assumes this money was already taxed before it was put into the trust. After money is placed into the trust, the interest it accumulates is taxable as income—either to the beneficiary or the trust. The trust is required to pay taxes on any interest income it holds and doesn’t distribute past year-end. Interest income the trust distributes is taxable to the beneficiary who gets it.

The money given to the beneficiary is considered to be from the current-year income first, then from the accumulated principal. This is usually the original contribution with any subsequent deposits. It’s income in excess of the amount distributed. Capital gains from this amount may be taxable to either the trust or the beneficiary. All the amount distributed to and for the benefit of the beneficiary is taxable to her to the extent of the distribution deduction of the trust.

If the income or deduction is part of a change in the principal or part of the estate’s distributable income, then the income tax is paid by the trust and not passed on to the beneficiary. An irrevocable trust that has discretion in the distribution of amounts and retains earnings pays trust tax that is $3,011.50 plus 37% of the excess over $12,500.

The two critical IRS forms for trusts are the 1041 and the K-1. IRS Form 1041 is like a Form 1040. This is used to show that the trust is deducting any interest it distributes to beneficiaries from its own taxable income.

The trust will also issue a K-1. This IRS form details the distribution, or how much of the distributed money came from principal and how much is interest. The K-1 is the form that allows the beneficiary to see her tax liability from trust distributions.

The K-1 schedule for taxing distributed amounts is generated by the trust and given to the IRS. The IRS will deliver this schedule to the beneficiary, so that she can pay the tax. The trust will fill out a Form 1041 to determine the income distribution deduction that’s conferred to the distributed amount. Your estate planning attorney will be able to help you work through this process.

Reference: Investopedia (July 15, 2019) “Do Trust Beneficiaries Pay Taxes?”

What Will New Acts of Congress Mean for Stretch IRAs?
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What Will New Acts of Congress Mean for Stretch IRAs?

The SECURE and RESA acts are currently being considered in Congress. These acts may impact stretch IRAs. A stretch IRA is an estate planning strategy that extends the tax-deferred condition of an inherited IRA, when it is passed to a non-spouse beneficiary. This strategy lets the account continue tax-deferred growth over a long period of time.

If a parent doesn’t need her Required Minimum Distributions, does it make sense to do a gradual Roth IRA conversion and use the RMDs to pay taxes on the conversion? Or should the parent invest the RMDs in a brokerage account?

There are several options in this situation, according to nj.com’s recent article, “With Stretch IRAs on the way out, how can I plan for my children’s inheritance?”

Congress is considering legislation with the SECURE and RESA Acts, that would eliminate the ability of children to create a stretch IRA, one that would let them to stretch distributions from the inherited IRA over their lifetimes.

Under the proposed SECURE and RESA Acts under consideration, the maximum deferral period will be 10 years. If the beneficiary is a minor, the period would be 10 years or age 21.

The best planning strategy for a parent would depend on her overall finances and what she wants for her children’s inheritance.

The conversion to a Roth may be a good planning move, depending on her tax bracket. Putting the money in a brokerage account is also an option.

A parent may also want to think about using the RMD proceeds to purchase a life insurance policy held by an irrevocable trust for the benefit of her children.

It’s best to contact an experienced estate planning attorney, so he or she can review the details of the parent’s finances and help her choose the best options for her situation.

Reference: nj.com (October 15, 2019) “With Stretch IRAs on the way out, how can I plan for my children’s inheritance?”

Can I Keep a Loved One’s Inheritance From Their Spouse?

A recent nj.com article asks, “How do I protect my niece’s inheritance from her husband?” The article says that in a scenario where someone plans to leave most of her estate to her niece but doesn’t want her estranged husband to get his hands on the money, she must be proactive to make sure the funds go where she intends them to go.

If this happens in New Jersey, the niece’s inheritance will be subject to the New Jersey inheritance tax. The tax is levied based on the relationship of the deceased to the beneficiary. In this case, the niece’s inheritance would be subject to an inheritance tax of 15 to 16%.

This inheritance tax is assessed, because the aunt is a New Jersey resident. It doesn’t matter where the beneficiary resides.

One option is for the aunt to leave the assets to the niece outright or in trust.

The laws in many states, like Missouri, South Carolina, and New Jersey, say that unless the parties otherwise agree, upon divorce there will be equitable distribution of their marital property. Marital property generally doesn’t include the property received by gift or inheritance, as long as that person didn’t co-mingle it with the marital property.

Therefore, the most economical way to transfer property to the niece, is to leave it to her in the testator’s will, with instructions for her to keep it separate and apart from her marital property.

An outright bequest may not be the best way to leave property to the niece, even though it’s probably the most economical method for the aunt.

However, if the aunt leaves the inheritance in trust, she’ll make certain the property isn’t commingled with marital assets.

Further, if the trust is properly prepared by an experienced estate planning attorney, the income from the trust will likely not be used to decrease any support to which the niece may otherwise be entitled from her spouse, in the event that they divorce down the road. The trust can also protect against other events, by instructing to whom funds should be paid upon the premature death of the niece. That would further prevent her estranged husband from ever being able to make a claim against the funds.

Reference: nj.com (August 21, 2019) “How do I protect my niece’s inheritance from her husband?”

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